The Profitable Nonprofit
July 23, 2007By William C. Barrett III, CPA/ABV, CVA, CTP, CCFM
Here's the scenario: The headquarters of an international professional association moved from California to Virginia Beach four years ago after a new executive director was hired. For the past two years, the association had experienced declining membership numbers, conference attendees and CPE revenues — as well as increased costs. Also, general operating expenditures increased to erode the half million dollar fund balance.
Four years after beginning the position, the executive director was terminated by the Board of Directors for poor performance. The interim executive director and current staff uncovered close to $25,000 in recent personal purchases on the association's credit cards and from the operating checking account.
The corporate attorney wanted a forensic accounting of the extent of the misappropriation. I was asked to put a local team together for this engagement, so we hit Virginia Beach to investigate the fraud.
Upon arrival, the interim executive director showed us what he had discovered, all in recent credit card and bank statements. Though he was leaving town, he, the president of the Board of Directors and the corporate attorney were all available by phone to help in any way.
Also, the bookkeeper would be available by phone, too. She had resigned the day after it was announced to the staff that a forensic investigation was to take place.
Well, the first week and a half went like this:
Accounting Records
There were few accounting records on the premises, and they had missing pages from statements and other supporting detail. The bookkeeper, aside from two phone conversations, never answered her phone or returned calls again.
The association used three computer programs to run its operations: (1) software on the executive director's computer; (2) membership software (more than 10 years old and in DOS) that tracked membership, meetings, publications, payments, etc.; and (3) the bookkeeper's Peachtree accounting software, used to log the check register. Only the open current-year transactions were on the bookkeeper's hard drive.
We learned that accounting documentation "was probably" in a storage locker, several miles away. Upon visiting the locker, we found some decrepit equipment and furniture and nearly 100 storage boxes of association records stacked in no particular order. However, several of the newer boxes with recent records were at the back of and underneath earlier boxes from prior years. The arrangement indicated that the boxes in the unit had been removed en masse, the contents of the later-year boxes explored and returned to the back of the unit, and then earlier-year boxes were heaped on top. Furthermore, later boxes had minimal sediment on the outside, while the earlier boxes were heavily covered with dirt.
Luckily, the local three-person CPA firm that did the association's financial statement and tax return preparation had electronic detailed general ledgers and adjustment journals for the past three years. They had also documented, over the same time period, journal entries requested by the executive director that capitalized general and administrative expenses.
The Initial Investigation
We first analyzed three years of credit card statements (minus the missing months of records). In this analysis, we used discovery sampling — a form of attribute sampling. Attribute sampling is a statistical means of estimating the proportion of a population that contains a characteristic, or attribute, of misdeed. In fraud investigations, the investigator hypothesizes that the expected error rate is zero; any error is considered an indication of fraud. Should even one error be detected, we know there is a problem.
An example of discovery sampling is finding a charge that does not belong on a professional association's credit card, like a day at a beauty spa (which we did find).
A week into the project, the IT manager of the CPA team I put together pulled us aside to discuss a feeling she had: the two remaining staff were making things disappear in the membership software database. She still had an original back-up taken at the start of our engagement, which only she and I knew about, but it now disagreed in volume with what was on the association's computer.
Catching Fraudsters in the Act
To test this theory, we planted documents on the computer that we would need the next day. We also decided to confide in the two suspected staff why we needed those documents: they would uncover a piece of the fraud. On the ninth day, the scandal broke.
The manager had been going through old issues of the association's magazines. We suspected the membership database had been padded — that reports to the Board on the total number of active members were inflated. The magazines included a section that listed members who had either retired or died. She was able to trace on the back-up database (now on her computer back at the CPA firm), and on the association's computer, that the deceased members were still on the active roster — even those who had died more than two years ago.
We told the professional development coordinator that we suspected the member roster was padded with deceased members, and the manager would look at it the next day. But, we instructed her not to tell the other staffer — the member services coordinator.
Mysteriously, by the next day the deceased members had somehow been finally laid to rest in the database.
It was time to conduct the forensic interview.
The Forensic Interview
The forensic interview comprises five general types of questions: introductory, informational, assessment, closing and admission-seeking. In routine interview situations with a goal of gathering information from neutral or corroborative witnesses, only three of the five types are normally asked: introductory, informational and closing questions.
If the respondent is being deceptive, certain types of hypothetical, nonaccusatory questions can be posed. By observing verbal and nonverbal responses, we can assess the respondent's credibility with some degree of accuracy. Admission-seeking interviews are reserved specifically for individuals whose culpability is reasonably certain. Admission-seeking questions are posed in an exact order designed to (1) clear an innocent person; or (2) encourage the culpable person to confess. These questions must not violate the rights and privileges of the person being interviewed.
For a forensic interview, I always have another team member present. In this case, it was a supervisor. During the course of the interview with the professional development coordinator, just as things were progressing from the introductory and informational into the assessment dialogue, the supervisor took a call and excused himself.
I was left alone with the coordinator, and that's when things got interesting.
She immediately became defensive, accusing us of not knowing what we were doing and stating that if members' names were missing, then the manager, who was not there at the time, probably messed up the database. She rose, and I then rose to walk away behind a table on the other side of the room. She opened the door closed by the supervisor and left.
To avoid further issues, I contacted the new director, president and the corporate attorney. All agreed to put the remaining staff on paid leave and to change the locks to the building. From then on, our fraud engagement took off.
In the End
Collusion. Trying to detect fraud in an environment of collusion is more difficult that trying to get a teenager to clean his room. At each step, there are multiple individuals all bent on self-preservation, and they can use uniform deception, concealment and rationalization tactics that can be insurmountable. Collusion adds significant costs and delays to the investigation.
Break the chain of collusion and the investigation can find its normal traction. The beauty of the double-entry system is that when you have a suspect debit, you can check the corresponding credit and the supporting documentation for all sides of the transaction. The drawback to most collusion cases is that there never seems to be enough ill-gotten-gain to keep everyone happy.
This engagement was no different. Pandora's Box opened for us, which included:
- All four staff members (two regular staff, the bookkeeper and the executive director) had home computer systems purchased out of the general fund.
- Three to four times a year, they all had dinner at the most expensive French restaurant in Virginia Beach.
- Grocery and furniture expenditures were rampant.
- Travel was also big, whether they brought husbands and children along to the professional conferences and educational seminars, or just had weekends in Atlanta or Washington, D.C., two favorite spots.
- While no checks were made to "Cash," there were over-normal amounts of checks cut to staff for reimbursables — all with no backup documentation.
And here is how these items were paid for:
- Accruals (capitalized expenses) over a three-year period had mushroomed from about $30,000 of prepaid conference, publication and seminar expenses to more than $125,000.
- Asset purchases reached more than $100,000 with no assets (i.e. computers, furniture, etc.) on site or in sight.
- The association had five $100,000 certificates of deposit (CD) on the books, yet only one at the bank. Outside of supporting the fraudulent expenditures, these were cashed and then deposited to the operating account as false revenue for the inflated number of active members, and as interest revenue on the CDs that were no longer in existence.
Lessons Learned
We were originally tipped off to the fraud by the manager's hunch about the membership numbers, and it turned out to be the right path to follow. Many times, following hunches can lead to important leads in breaking forensic accounting cases.
Also, forensic accounting is not often a 9-to-5 endeavor. Often, you have to work long hours to keep up with myriad record-combing, interviewing and investigating. Though I didn't get to enjoy much of Virginia Beach during that trip, I was able to come back to Richmond and reflect upon my adventure. I call my love of this field, "The Good Life."
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